A wash sale is when an investor sells a security at a loss and then buys the same or substantially similar security within 30 days. The sale is considered “washed” because the investor cannot claim the loss on their taxes. The wash sale rule applies to both stocks and bonds.
The Wash Sale Rule
Let’s say an investor owns stock in Company A. The stock has lost value, so the investor decides to sell it and claim the loss on their taxes. The next day, the stock goes back up, so the investor rebuys it. Doing this avoided paying taxes by timing their sales correctly. The IRS implemented the wash sale rule to prevent investors from taking advantage of the tax system.
The wash sale rule does not apply to retirement accounts such as IRAs and 401(k)s. This is because retirement account holders are already getting a tax break on their investments. For example, 401(k) contributions are made with pre-tax dollars, so there’s no need to deduct losses from these accounts on your taxes.
IRA trades can trigger a wash sale in a taxable account, but not the other way around (i.e. you take a loss in a taxable account and re buy in a retirement account). Wash sales that happen in an IRA permanently disallow actual losses that occurred in your taxable account. When using the Audit My Broker feature in Traderfyles, the algorithm adjusts for wash sales that may occur as a result of IRA trades and makes necessary adjustments for tax reporting purposes. You can also generate a stand alone report that provides the totals for wash sales that have been permanently disallowed due to IRA Trades.
The wash sale rule can be confusing, but it’s important to understand if you want to minimize your taxes.
Bottom Line
Some taxpayers might view finding legal loopholes as morally ambiguous. It is important to understand how our tax system works and what methods we can use to stay within the law while saving money. Wash sales are one way that savvy investors can do just that. By understanding how they work, you can ensure you’re getting the most out of your investments.
